Meanwhile in China, the Return!

Not so long ago I wrote about a growing concern of the debt situation in China. That particular issue pertaining to loans being disguised to look like bank to bank loans has not gone away since, but it seems finance specialists are not really picking up on it. For sure there are many other economic issues around the world these days to keep us all busy and worried enough, but I would counter by saying that a slow-down of the economic growth in China such as we are witnessing will only make the debt issue considerably worst.

Well, it seems as if there are more bad news coming out of China. Chinese property developers have found a way of raising funds through a method that makes their debt loads seem less than what they actually are. They do this by issuing perpetual securities.

I bet some of you right now are wondering what perpetual securities are, and why are they a problem. I suppose just as perpetual movement is something utopic, these securities could seem equally utopic as they are really loans that are never redeemed. Essentially a perpetual security is a corporate bond with a high interest rate and no maturity date.

These securities are increasingly popular among Chinese property developers that are currently suffering from the country’s real-estate slump and government limits on their ability to tap credit from state-controlled banks. One particular advantage to the issuers is that they can be treated on the balance sheet as equity rather than debt. That is because payments are made at the discretion of the company, so they are considered as dividends rather than interest payments.

The result of this is that some property companies are looking financially much better than what they really are. Analysts feel that these instruments are toxic for investors as they basically mask the real leverage and profitability of a company.

As of June, eight listed property developers had issued perpetual securities totaling 86.5 billion yuan ($14.1 billion), nearly double the 44.1 billion yuan recorded in the whole of 2013. If these perpetual securities would be reclassified as debt rather than equity, gearing would be considerably higher.

Essentially the sudden success of these perpetual securities is the result on the new controls on bank loans as I wrote about earlier. So, when regulators at least try to do something to avoid the situation getting out of hand (although I think they are still doing way too little), the market comes up with a new alternative that is probably even more toxic. To give you an example we can look at Guangzhou based developer Evergrande. According to Citi Research, they have issued $2.86 billion in new financing this year as perpetual securities. If these were to be reclassified as debt, their leverage would jump from 90% to 248%! Just imaging then the impact if the Chinese property market was to crash, something that is looking all the more likely each day…

In my opinion the Chinese wonder is looking more and more like a house of cards each day, but investors just don’t seem to want to see the reality as long as they are making money.